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Germany, France Present Broad Plan to Better Coordinate European Economic Policy

Source: WSJ - Brian Blackstone and David Gauthier-Villars

Posted on 17 Aug 2011

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Amid growing fears that a slowdown in the region could accelerate the debt crisis that has pushed the Continent's common currency to the brink of collapse, Germany and France presented a broad plan to better coordinate economic policy across the 17-nation euro zone.

Meeting in Paris, German Chancellor Angela Merkel and French President Nicolas Sarkozy proposed that euro-zone leaders gather more often to better coordinate budget and tax policies across the currency bloc. They also recommended electing European Council President Herman Van Rompuy as euro-zone chief, but gave no indication that he would wield much power.

The announcement, which came on the heels of news that economic growth had stalled across much of Europe during the second quarter, failed to convince jittery investors that the region's leaders were willing to go far enough to resolve its problems.

Economic growth slowed to an annualized rate of 0.5% in Germany during the second quarter. The gross domestic product of the 17 nations that have adopted the euro rose at an annualized rate of 0.7% during the quarter, according to data from the European Union's statistics agency Eurostat. That was half the growth rate economists expected, stoking fears of a renewed recession.

The slower-than-expected growth, coupled with darkening business sentiment, signal that even Europe's strongest economies are now suffering from the global soft patch that hit other major economies early this year. Europe's growth outlook has taken on new urgency amid concerns about the ability of Italy and Spain, the euro-zone's third- and fourth-largest economies, to refinance large piles of government debt.

"There's a real underlying slowdown going on that is spreading to the core," said Jennifer McKeown, economist at consultancy Capital Economics, adding that the sudden weakness in Germany and France was "particularly shocking."

The French and German leaders recommended that euro-zone heads of states and governments meet at least twice a year. Although euro-zone leaders have met several times since the global financial crisis broke in 2008, such summits were never institutionalized.

In an effort to enforce fiscal discipline, Mr. Sarkozy and Ms. Merkel urged all 17 countries to enshrine balanced-budget rules in their constitutions by next summer. Several countries rejected the idea earlier this year, but the proposal is gaining new traction as debt woes spread to some core euro-zone countries. The leaders also said they would make proposals to align the corporate-tax regimes of France and Germany.

European stock markets had closed before the proposals were announced. In the U.S., the Dow Jones Industrial Average lost about 140 points as the French and German leaders spoke, then recovered some of those losses to end the day down 76.97 points, or 0.67%, at 11405.93.

Europe's second-quarter weakness stretched from fragile and debt-ridden countries such as Portugal to Europe's industrial powerhouse, Germany, which slipped from boom-like expansion in previous quarters. Though some cooling from Germany's first-quarter pace of 5.5% had been expected, the extent of the slowdown caught forecasters by surprise.

France's economy was flat, while Spain grew under 1%. Italy's 1% growth rate made it the best performer among large euro members.

What happens in Germany has ripple effects in much of Europe. Spain shipped more than €22 billion ($31.6 billion) in goods to Germany last year, and Italy shipped twice that, providing a critical offset to weak domestic demand.

The stagnation will likely force the European Central Bank to put its rate-hike campaign, aimed at taming inflation, on hold for many months, analysts say, or risk exacerbating Europe's economic troubles.

Unlike previous quarters when strength in the region's prosperous core of Germany, France and the Netherlands more than offset stagnation and contraction in southern Europe and Ireland, weakness was widespread in the second quarter.

"We were growing very strong until May, and then in June and July it dropped," said Michael Rentschler, vice president at ERNI Electronics nearStuttgart, Germany, which makes connectors and electrical transmission equipment for the telecommunications, medical and transportation industries.

"I think we have to look for a much weaker second half of the year."

The biggest swing, he said, has been from Asia, which had been a reliable source of growth. Orders from there, he said, shrunk from year-ago levels.

He said that it is unclear whether business is in a temporary lull or a more pronounced slowdown, and that he expects to get a better reading after Europe's summer holidays. Until then, his company is reducing overtime and other expenses and drawing down inventories.

Just as Germany's first-quarter surge likely overstated its strength, the signs of stagnation in the second quarter may not signal the end of the boom in Europe's largest economy.

"The truth lies in between," said Andreas Rees, Munich-based economist at lender UniCredit, who expects Germany to grow in the 2% range in coming months, in line with its long-term average. Despite last quarter's near stall, German growth will likely reach 3% in 2011 for a second-straight year, he predicted.

"For us and for many other companies, we don't see that the economy is weakening," said Dagmar Bollin-Flade, chief executive at Frankfurt's Christian Bollin Armaturenfabrik GmbH, which produces specialty valves for the petrochemical industry and power plants. The company, which employs about 30, relies on exports for about half its revenues. Ms. Bollin-Flade still sees strong demand from power plants in Asia and other parts of Europe, and expects 5% to 10% order growth for 2011.

But some of Germany's global brand-name companies are warning of slower growth ahead. Industrial conglomerate Siemens AG said last month that global economic risks are on the rise. Chemicals company BASF SE warned that debt problems in Europe and the U.S. could hurt economic growth.

With major, industrialized countries such as the U.S. and Japan recovering weakly, if at all, German industry has relied on demand from fast-growing emerging markets including Brazil, Russia, India and China to drive demand for its luxury cars and specialty machine tools.

Many of those countries are trying to cool off their economies, which show signs of overheating, by raising interest rates and slowing the growth of credit. How successful they are in achieving "soft landings" of strong growth and low inflation may be an even bigger issue for Germany's economy than the debt crisis along Europe's southern fringe and Ireland, some analysts say.

"This is not a debt story. This is a China and emerging markets story," said Mr. Rees.